Question

Hercules Exercise Equipment Co. purchased a computerized measuring device two years ago for $72,000. The equipment falls into the five-year category for MACRS depreciation and can currently be sold for $31,800. A new piece of equipment will cost $200,000. It also falls into the five-year category for MACRS depreciation. Assume the new equipment would provide the following stream of added cost savings for the next six years. Use Table 12–12. Use Appendix B for an approximate answer but calculate your final answer using the formula and financial calculator methods.

Year		Cash Savings
1		$	69,000
2			61,000
3			59,000
4			57,000
5			54,000
6			43,000

The firm’s tax rate is 25 percent and the cost of capital is 12 percent.

h. Determine the incremental depreciation between the old and new equipment and the related tax shield benefits. (Enter the tax rate as a decimal rounded to 2 decimal places. Round all other answers to the nearest whole dollar.)

i. Compute the aftertax benefits of the cost savings. (Enter the aftertax factor as a decimal rounded to 2 decimal places. Round all other answers to the nearest whole dollar.)

Year Depreciation on New Equipment Depreciation on Old Equipment Incremental Depreciation Tax Rate Tax Shield Benefits 0.25 0.25 0.25 0.25 0.25 0.25

j-1. Add the depreciation tax shield benefits and the aftertax cost savings to determine the total annual benefits. (Do not round intermediate calculations and round your answers to the nearest whole dollar.)

Answer 1

h) Depreciation on Depreciation on Incremental Tax Shield Year New Equipment Old Equipment Depreciation Tax Rate Benefits 1 $ 40,000 $ 13,824 $ 26,176 0.25 $ 6,544 2 $ 64,000 $ 8,280 $ 55,720 0.25 $ 13,930 3 $ 38,400 $ 8,280 $ 30,120 0.25 $ 7,530 4 $ 23,000 $ 4,176 $ 18,824 0.25 $ 4,706 5 $ 23,000 $ 23,000 0.25 $ 5,750 6 $ 11,600 $ 11,600 0.25 $ 2,900 Year 2 $ 3 $ 4 $ 5 $ 6 $ Savings 68,000 58,000 56,000 54,000 51,000 40,000 Aftertax (1-Tax rate) Savings 0.75 $ 51,000 0.75 $ 43,500 0.75 $ 42,000 0.75 $ 40,500 0.75 $ 38,250 0.75 $ 30,000 j-1) Year Tax Shield Benefits 6,544 2 § 13,930 3 $ 7,530 4,706 5 $ 5,750 6 $ 2,900 $ $ $ $ $ $ Aftertax Total annual Savings | benefits 51,000 $ 57,544 43,500 $ 57,430 42,000 $ 49,530 40,500 $ 45,206 38,250 $ 44,000 30,000 $ 32,900

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